Manufacturing is the economy's rock star: it expanded 9.1 percent y-o-y in Q2 2014 from 6.5 percent in Q1.
This and robust service demand pushed GDP to 5.5 percent y-o-y from 4.8 percent. The economy will likely accelerate further in H2 2014 on better exports and domestic demand. Still, the pace of growth will likely remain below trend due to dampened consumer confidence, dragged down by bad debt. Domestic demand, thus, is still the key to Vietnam having above 7 percent growth in the medium term. For now, households and corporates are not in a hurry to spend unless they see concrete reforms.
Implications
Vietnam is an export-oriented economy, with exports accounting for 77 percent of GDP in 2013 and likely rising to 80 percent in 2014. Despite sluggish global demand, exports have expanded by double digits, a trend that we expect to continue in the next two years. In June, exports grew 14.9 percent y-t-d, a slowdown from 15.4 percent in May, reflecting temporary disruptions. With activity normalising and external demand picking up in H2 2014, exports should accelerate in the coming months.
The economy has weathered the slowdown of domestic demand relatively well due to stellar export performance. In Q2, manufacturing output rose 9.1 percent y-o-y in Q2 2014 from 6.5 percent in Q1 2014. We expect the sector to continue to expand, thanks to increased investment, trade agreements such as the EU-Vietnam Free Trade Agreement (FTA) likely concluding end 2014, and better external demand. Manufacturing continues to increase its contribution to growth. The service sector has decelerated but remains robust thanks to gradually rising incomes and improving demographics. Should confidence in the economy improve, the service and construction sectors will make a comeback, fuelling GDP growth to above 7 percent.
However, in the next two years, our base case scenario shows growth will still be significantly below trend. The sluggish pace of public investment, and banking sector and SOE reforms are dampening consumer confidence. A still largely unresolved bad debt issue will keep household and corporate purse strings tight. Year-to-date in May, credit only expanded by 1.3 percent. We expect credit growth to accelerate in H2 2014, boosting domestic demand marginally. Inflation will also accelerate in early Q3 2014 on higher service costs and improving domestic demand but will likely settle between 5-6 percent by year end. The central bank, thus, will comfortably keep the OMO rate at 5.0 percent for the rest of the year.
While growth will be sluggish in the short term, Vietnam can come back in a big way in the medium term. Initiatives such as the EU-Vietnam FTA and Trans Pacific Partnership (TPP) will further remove external trade barriers and boost Vietnam manufacturing competitiveness globally. The government is slowly removing internal trade barriers, with infrastructure investment more targeted to facilitate trade and domestic retail flows. What remains is the regulatory framework for public, SOE, and banking sector reforms and its enforcement. To this end, reforms are proceeding with a two-step forward and one step backward approach, reflecting the government indecision about the role of the state sector in an increasingly globally-integrated economy.
Source: Press Release
